Smartbook 10 PDF

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1. Which of the following are the three main sources of financing a business's

capital investments? (Check all that apply.) ● Internally generated funds ● Borrowings from long-term creditors ● Investments by owners

2. An advantage to financing with debt is that interest is tax-deductible. 3. A bond's maturity date is the date on which the bond principal will be repaid

in full. 4. How would Skaters World, Inc.'s return on equity (ROE) be different if the

company were to issue $200,000 of 10% bonds instead of $200,000 in shares? Assume income before interest and taxes is estimated to be $100,000, income taxes are 35% and shareholders' equity is initially $300,000. ROE would be higher with bonds. Reason: With bonds, Net income will equal $52,000 (=$100,000 - ($200,000x10%))x(100%-35%) and the ROE will equal 17% (=$52,000/$300,000). With shares, Net income will equal $65,000 (=$100,000x(100%-35%)) but the ROE will only equal 13% (=$65,000/($300,000+$200,000)). 5. Lack-Luster Corporation borrowed money by issuing a $100,000 installment note

payable that required $10,000 annual payments, plus interest of 12% on the unpaid balance prior to the payment. The interest expense at the end of the third year was: $9,600 Reason: The unpaid balance at the end of the third year, prior to payment, was $80,000 ($100,000 - ($10,000 x 2)). The interest expense would be 12% of $80,000, or $9,600. 6. Which one of the following is NOT one of the three main sources of financing a

business's capital investments? Payment of dividends 7. Which of the following are reasons a company would want to issue bonds instead

of shares? (Check all that apply.) ● Current shareholders maintain control. ● Interest expense is tax-deductible.

8. The ______ is the interest rate on the date the bonds are issued and used to

determine the amount of interest expense. (Select all that apply.) ● yield ● market rate of interest ● effective rate of interest

9. Which of the following information is found on a bond indenture? (Check all that

apply.) ● Interest payment dates ● Stated rate ● Maturity date ● Principal

10. How return on equity be different if a company were to issue $100,000 of 10%

bonds instead of $100,000 in shares? Assume income before interest and taxes is estimated to be $100,000, income taxes are 21% and shareholders' equity is initially $200,000. Return on equity would be higher with bonds. Reason: With bonds, Net income will equal $71,100 (=$100,000 - ($100,000 x 10%)) x (100% - 21%) and the return on equity will equal 35.6% rounded (=$71,100/$200,000). With shares, Net income will equal $79,000 (=$100,000 x (100% - 21%)) but the return on equity will only equal 26.3% (=$79,000/($200,000 + $100,000)). 11. The journal entry to record the issuing of 100 bonds at their $1,000 face value

will include a debit to Cash and a credit to Bonds payable. 12. Ignacious Construction purchased a tractor by issuing a 5-year

non-interest-bearing note for $100,000 when the market rate of interest was 10%. The note's fair value when issued using a 10% rate is $62,090. When the note was issued, the tractor was recorded at a value of: $62,090 Reason: The tractor would be recorded at the fair value of the note. The difference is accounted for as a discount on notes payable which is amortized over the term of the note. The first year amortization of the $37,910 discount would be $6,209 (0.10 x $62,090). 13. The issue (sale) price of a bond equals the sum of the present value of the

principal and interest payments.

14. The market interest rate on a bond is the interest rate investors demand on the

day a bond is issued and is used to calculate interest expense. 15. The two methods of amortizing bond discounts or premiums are called the

effective-interest and the straight-line methods. (Check all that apply.) 16. On the maturity date, the bondholders of $100,000 of bonds payable that were

issued at $90,000 will receive $100,000 in cash plus the interest owed. 17. ABC Company received $9,631 for its 5-year, 10% bonds with a total face value

of $10,000. The market rate of interest was 11%. The bonds pay interest annually on December 31. How much interest expense will ABC Corporation record on the first annual interest payment date using the effective-interest method? (Round to the nearest dollar). Reason: Interest expense=$9,631 x 0.11=$1,059. 18. If ABC Company receives $100,000 cash in exchange for issuing 100 bonds at

their $1,000 face value, the transaction will be recorded with a debit to Cash of $100,000 and a credit to Bonds payable of $100,000. 19. Munchen Company sold bonds at a premium. Over the life of the bonds, the

carrying value of the bonds will decrease. 20. When recording the payment of interest using the effective-interest method, the

entry will include a ______ to Discount on bonds payable in the amount of the difference between the cash payment based on the ______ interest rate and interest expense based on the ______ interest rate. credit; stated; market 21. Discounters, Inc., issued $50,000, 4-year, 6% bonds that pay interest annually on

January 1 when the going market interest rate was 7%. The issue (sale) price of the bonds, rounded to the nearest $1, equals $48,307. Reason: Using the appropriate present value amounts from your textbook or calculator, the bond's sales price equals $48,307 (= ($50,000 x 0.7629) + (($50,000 x 0.06) x 3.3872)). 22. On January 2, 2017, Schneider Company issues $100,000 of 6% bonds. The

market interest rate is 7%. Interest of $3,000 is payable semi-annually on June 30 and December 31. The bonds mature in 5 years. The bond issues for $95,842. On June 30, 2017 the company should recognize a discount amortization of $354. Reason: ($95,842 x 0.035) – $3,000 = $354

23. The discount on a bonds payable becomes additional interest expense over

the life of the bonds. 24. The book value of bonds payable ______. (Check all that apply.)

● decreases as the bond premium is amortized ● increases as the bond discount is amortized ● equals the principal at the maturity date

25. On January 1, Bondz, Inc. issued $100,000, 8%, 5-year bonds for $96,107.60

given a market rate of 9% and annual interest payments. The interest expense, using the effective interest rate method, for the 1st year ended December 31 equals $8,649.68. (Round to the nearest cent.) 26. With each payment of interest on a bond sold at a discount using the

effective-interest method, the bonds payable book value will increase. Reason: Amortization of a discount causes the book value of the bond to increase with each payment because the Discount on bonds payable, a contra-liability, is credited by the difference between the lower cash payment based on the stated rate and the higher interest expense based on the market rate. Thus, Interest expense (which equals the market rate times the increasing book value) increases. 27. Slater Company issues $1 million face amount bonds for $1.1 million. On the

date of maturity, the carrying value of the bonds (assuming that interest has already been accrued) will be equal to $1 million. 28. The normal balance for Discount on bonds payable is a debit. 29. On January 1, 2018, Bondz, Inc. issued $100,000, 8%, 5-year bonds for

$96,107.60 given a market rate of 9% and annual interest payments. The entry to record the 1st interest payment on December 31, 2018 (assuming no prior adjustments and the effective-interest method) includes a(n) ______. (Check all that apply.) ● $649.68 credit to Discount on bonds payable ● $8,000 credit to Cash ● $8,649.68 debit to Interest expense

30. A bond with an issue price of $10,100 and a face value of $10,000 was issued at

a premium.

31. The difference between the effective interest and the interest paid represents

amortization of a discount or premium. 32. The 5-year present value of $1 at 10% equals 0.6209 and at 9% equals 0.6499.

The 5-year present value of an annuity at 10% equals 3.7908 and at 9% equals 3.8897. A $1,000, 10%, 5-year bond that pays interest annually would sell for how much if the going market rate of interest were 9%? $1,038.87 Reason: The present value of $1,000 must be discounted the market value (not the stated interest rate) at 9% or ($1,000 x 0.6499) plus the present value of an annuity of $100 at 9% for 5 years or ($100 x 3.8897) equals the price of the bond. 33. Identify the true statement about the effect of selling an amortized bond on the

carrying value of bonds payable. ● If the amortized bond is sold at a discount, the carrying value of the bond will increase. ● If the amortized bond is sold at a premium the carrying value of the bond will decrease.

34. ABC Corporation issued $100,000 of 10%, 5-year bonds on January 1, 2018, for

$92,280. The market interest rate when the bonds were issued was 12%. Interest is paid semi-annually on January 1 and July 1. Using the effective-interest amortization method, how much cash will ABC pay bondholders on July 1, 2019? $5,000.00 Reason: Payment to bondholders = $100,000 x 10% x (6/12) = $5,000 35. The Discount on bonds payable account is a contra account to Bonds

payable. 36. Bond premium is the amount by which a bond's issue price exceeds its face

value. 37. If ABC Company issues 100 of its $1,000 bonds at a price of 110 or $1,100 each,

the journal entry to record the transaction (net of premiums or discounts) includes a ______. (Check all that apply.) ● credit to Bonds payable of $110,000 ● debit to Cash of $110,000

38. Mortars, Inc. issued $100,000, 10-year, 9% bonds that pay interest annually on

January 1 when the going market interest rate was 8%. The issue (sale) price of the bonds, rounded to the nearest $1, equals $106,711. Reason: To determine the price requires discounting the future cash flows using the 8% market rate of interest or $106,710.90 = ($100,000 x 0.4632) + (($100,000 x 0.09) x 6.7101) 39. If ABC Company issues 100 of its $1,000 bonds at a price of $1,100 each for a

total of $110,000, the journal entry to record the transaction includes a ______. (Check all that apply.) ● debit to Cash of $110,000 ● credit to Premium on bonds payable of $10,000 ● credit to Bonds payable of $100,000 40. The Times Interest Earned ratio equals Net Income plus Interest Expense plus

Income Tax Expense divided by interest expense. 41. On January 1, 2018, Bondz, Inc. issued $100,000, 8%, 5-year bonds for

$96,107.60 given a market rate of 9% and annual interest payments. Using the effective interest method, the entry to record the 2nd interest payment on December 31, 2019 includes a(n) ______. (Check all that apply.) ● $8,708.16 debit to Interest expense ● $708.16 credit to Discount on bonds payable ● $8,000 credit to Cash

42. Bonds sometimes offer different features with respect to early retirement.

Callable (redeemable) bonds may be called for early retirement at the option of the issuer. 43. There are 2, 10-year, $1,000 bonds: one has an 8% stated rate and the other has

a 9% stated rate. Given they are issued when the market rate of interest is 7%, and they pay interest annually, which bond would result in a larger credit to Bonds payable (net of premiums or discounts)? 9% Reason: The 9% bond pays a higher interest and thus would be issued at a higher price than the 8% bond. The higher premium would result in a larger credit to Bonds Payable. 44. A Lease is a contractual arrangement in which an owner provides a user the

right to use an asset for a specified period of time. (Enter one word per blank)

45. If ABC Company issues 100 of its $1,000 bonds at a price of $1,100 for a total of

$110,000, the journal entry to record the transaction includes a credit to Premium on bonds payable of $10,000. 46. Coverall, Inc. had the following amounts for the year ended: Interest expense of

$1,000, Dividend income of $2,000, Net income of $10,000, Income taxes of $3,000 and Earnings per share of $3. The Times Interest Earned ratio equals 14. Reason: 14 = ($10,000 + 1,000 + 3,000)/$1,000 47. When a company leases an asset on a short-term basis, the agreement, called

a(n) operating lease, does not transfer substantially the risks and rewards of ownership from the lessor to the lessee. 48. On-a-Roll Bakery has $20,000 in current liabilities, $100,000 in long-term

liabilities, and $80,000 in shareholders' equity at December 31, 2020. Its debt-to-equity ratio equals 1.50 Reason: Debt-to-equity ratio=($20,000+$100,000)/$80,000 49. Bonds sometimes offer different features with respect to early retirement.

Retractable bonds may be turned in for early retirement at the option of the bondholder. 50. Cashews, Inc. issued $100,000, 6% bonds at face value on January 1. The

bonds pay interest semiannually on June 30 and December 31. For the year ended December 31, the amount of interest paid equals $6,000 and is reported on the statement of cash flows as a(n) operating activity. 51. Repayments of formal, long-term debt contracts are classified as Financing

activities. 52. When a company leases an asset on a short-term basis, the agreement, called

a(n) operating lease, does not transfer substantially the risks and rewards of ownership from the lessor to the lessee. 53. If total assets increase, but total liabilities remain the same, what is the impact on

the debt-to-equity ratio? It decreases. 54. The payment of interest can be reported either as an operating activity or a

financing activity on the statement of cash flows. True 55. Issuing additional shares to owners is classified as a(n) Financing activity...